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July 06, 2009

Is there a difference between money and currency?

It is important to note that money does not really change. Money is the function it
performs, so money is still the same thing it always has been from the moment when it
first was invented in pre-history.iv Namely, money is a mental tool used for economic
calculationv that ingeniously enables each of us to communicate what we value in an
exchange. What changes throughout monetary history is currency. It evolves, and the
biggest change ever occurred in 1694.

Until 1694, currency was always an asset in the hands of whoever held it, something
tangible. Gold and silver were the most popular forms of currency, but history records
that other assets also were used, such as cows, food crops, shells, beads, and other
tangible items considered to be useful or rare.

The nature of currency evolved as mankind progressed, and various scientific
achievements made currency more efficient and more reliable. For example, if you look
at the evolution of coins over the centuries, you can see marked improvement.

The improvements were important. As coins became more reliable, the costs of
conducting commerce were reduced, and reducing costs is always a good thing. By
lowering the impediments to commerce—and the costs of handling currency and making
payments are an impediment—commerce itself is promoted, and as commerce expands
and develops, our living standards rise. So it was natural that new advancements that
improved the currency of the day were welcomed widely, as was the advancement
introduced by the Bank of England concurrent with its creation in 1694.

Gold and silver coins had disadvantages that were well-recognized. They were bulky,
hard to carry, impractical in large denominations because of the weight that would be
required, etc. What is worse, coins wore out from usage, wasting some of the precious
gold and silver contained in the coin.

To overcome the shortcomings of precious metal coin, the Bank of England introduced
an important advancement that made currency more efficient. That innovation enabled
gold and silver coins to remain safe and secure in the Bank’s vault while paper promises
to pay weights of precious metal—dubbed “banknotes”—circulated as currency in place
of the coins. Paper as a circulating medium had obvious advantages of efficiency and cost and at any time—or in other words, on demand—could be redeemed for coin. What
is more, because it was opened under a royal charter, the Bank of England and its paper
currency were perceived to be safe, and so they were—for about three years.

By 1697, the world’s first banking crisis was under way. The Bank of England had
issued far more paper than it had physical metal on hand,vi primarily silver, because that still was the preferred metal of the day in England. Therefore, the crisis arose because people rushed to convert their paper currency into silver coin, with the result that the Bank of England’s new currency appeared to be a failure.

Despite ongoing monetary upheaval, the Bank of England persevered (even back then,
government-sponsored enterprises seemed to take on a death-defying life of their own).
But that monetary crisis did have one beneficial and constructive result: It made self-
evident to everyone at the time that a paper currency promising to pay metal (a money
substitute) was different from money (gold or silver) itself. After all, a bank liability is fundamentally different from a tangible asset.

What the Bank of England had done was to stand currency on its head. Until 1694,
currency always had been a tangible asset (mainly gold and silver fabricated into coins). Thereafter, the new paper currency was not money; it was only a money substitute circulating in place of coin. This new currency was no longer a tangible asset; it had become a liability of a financial institution. This difference is as great as that between night and day, or more to the point, between assets and liabilities.vii

The impact of this change was so profound that it had an invasive impact on the
economy, with many adverse consequences. The insidious monetary turmoil wrought by
the Bank of England’s new currency persisted. To figure it all out, the British monarch, William III, turned for help to the greatest mind of the day, Sir Isaac Newton, who was appointed Master of the Mint in 1699.

Over the next several years, Newton restored order where there had been Bank of
England-created chaos. He did this by inventing and putting into practice what we now
call the classical gold standard. That was a monetary system operating under rulesviii that Newton established that were followed voluntarily by banks and later by other
governments that eventually adopted in their own country the Bank of England’s paper
currency innovation.

Newton’s rules resulted in automaticity, which is what made the gold standard so
effective. It was reliable and predictable. It was self-regulating when left unhindered, with capital flows over time tending to harmonize trade imbalances that arose from disparate economic conditions in different countries.

Newton recognized that the paper banknote was an important advancement that made
currency more efficient. But he also understood that paper currency was not money and,
even more so, that paper currency could be created to excess, which would result in
monetary turmoil that in turn would have an adverse impact on economic activity. In other words, he realized that paper currency was useful, but only if it had some standard by which it could be measured and controlled. He achieved these objectives with the gold standard that he created.

The Demise of the Gold Standard

Newton’s invention remained largely untouched from its implementation in 1707 until
1914. I say “largely” because the rules of his classical gold standard occasionally were broken. During periods of war, for example, the redeemability of paper into coin often was suspended, and credit was expanded beyond the prudent limits that normally
prevailed. But the rules governing the gold standard remained in place, more or less,
with the wartime suspensions usually lifted soon after hostilities ceased. Further,
redeemability of banknotes into coin was re-establisheddeflated the war-induced credit expansions.

Over time, however, bankers and politicians began to understand that, if they broke
Newton’s rules, they could gain an advantage. Bankers would make a greater profit
because they could expand credit (make loans) beyond the self-imposed constraints.
Politicians could gain greater power because, instead of being restricted to just spending gold, they envisioned creating a seemingly unlimited amount of money-substitutes and spending those instead. Newton’s rules were voluntary and worked only insofar as banks and governments agreed to them. By the 20th century, bankers and politicians were not just breaking the rules—they were discarding them.

Thus, given the powerful interests lining up against it, it is not surprising that the classical gold standard began to be depicted as undesirable, despite its splendid 200-year track record of maintaining relatively stable prices. What was worse, the classical gold standard started to be blamed for things for which it was not responsible. For example, it was not the gold standard that caused the Great Depression but, rather, imprudent credit expansion by banks, which was made worse by the growth of government and the rising expenditures that the burden of government entailed.ix The last vestiges of the gold standard were jettisoned in August 1971,x ushering in the present era of fiat currency regimes.

It should be clear by now why Keynes was taking a potshot at the gold standard. It is not surprising that Keynes—whose iconoclastic theories supported government management of the monetary system—would claim that the gold standard was a barbarous relic. Even though Keynes was no fan of gold, he no doubt understood that it would be foolhardy to attack gold itself. That would come later, from anti-gold propagandists and central bank apologists misusing what Keynes really wrote. But that is not quite the whole story.

The Real Barbarous Relic

There is indeed a barbarous relic, but we now know that it is neither gold nor the gold standard because of the useful role that gold played for two centuries before World War I. Rather, the barbarous relic is central banking itself.

Central banks are barbarous in part because they conspired to put an end to Newton’s
brilliant invention that safeguarded sound money for 200 years. It is the process of
central banking itself, as it has come to be practiced, that deserves the greatest public wrath.

Central banking is barbarous for the following reasons:

1. Money is a product of the free market. It is a fundamental building block of our
society because it allows people to interact with one another in the market process.
Money existed long before governments and central banks began to “manage” it.
Tragically, instead of being a neutral and unfettered tool in commerce, fair to one and all, money now has become a matter of force and decree, which is disruptive to the market process and therefore harmful to society.

2. Prior to the creation of the Bank of England, every exchange in the trading activity that we call the market process tendered value for value. In other words, gold was exchanged for land, silver for food, etc.—assets were traded for assets.xi The Bank of England changed this process by creating money substitutes. Its banknotes are not a tangible asset like gold or silver. Banknotes are merely money substitutes and not money itself. Money substitutes are a liability of the bank issuing that paper currency, and money substitutes create all sorts of payment risk that one does not have when using tangible assets as currency.

3. Central banks act in secrecy; consequently, they are not held accountable. For
example, the so-called “Open” Market Committee of the Federal Reserve is far from
“open.” It meets and makes decisions behind closed doors, and the minutes released one
month later are thoroughly redacted, leaving outsiders in the dark about the members’
deliberations. Central bankers consider themselves—and act as if they were—above the
law. Moreover, this secrecy favors the insiders, and it is this fundamental principle upon which central banks’ market intervention has been constructed, including, for example, their intervention in the gold market.xii

4. Central banks have freed governments from having to ask their citizens—through their elected representatives—for more taxes.xiii Central banks can acquire government debt and use it to create currency out of “thin air” for governments to spend on their latest whims. Even worse, through their policiesgovernments to steal from their citizens.

5. There are several tools in the central banks’ arsenal, and one of them is disinformation, which they regularly practice. For example, central banks have come to make us believe that inflation is “rising prices.” But wet streets do not cause rain. By changing the definition of inflation to one of “rising prices” rather than what it really is—monetary debasement engineered by central banks—the true culprits (the central banks themselves) are masked.

6. Not only are central banks guilty of disinformation, but deception is one of their most frequently used tools. The history of banking is replete with examples that demonstrate not just a lack of disclosure but, rather, outright deception. To give just one example, consider how central banks today account for their gold loans. They carry both gold in the vault and gold out on loan as one line item on their balance sheets.xiv In effect, central banks are saying that they can ignore the truthful disclosure established by Generally Accepted Accounting Principles, and as a result they can report both cash and accounts receivable as one and the same thing. Accounting like that would make even the fraudsters at Enron blush.

7. Central banks in effect have turned the market into a command, i.e., state-run,
economy. The power to create money out of thin air brings with it the much greater
power to control a nation’s economy and therefore the economic destiny of millions.
Central bankers today act like the former Soviet Union politburo members, who pulled
strings and pushed buttons to try making the economy—which means each and every one
of us who participate in the economy—bend to their control. But it is not only the
economic destiny of millions that is determined by central banks; subtle but potentially
more disturbing issues are raised by the exercise of power by central banks.

8. Central bankers and their comrades in government know that the command economy
power that they have claimed forces them to walk a fine line between prosperity and
economic collapse, given the inherent fragility of the credit-based monetary system that
they operate. To try to reduce this ever-growing fragility—in a vain attempt to make it
easier for central banks to control the command economy effectively and totally—
governments take away peoples’ freedom. Central banks usher in controls like the
reporting of bank accounts and funds transfers and policies such as the “too big to fail” doctrine that underwrites bad decisions at banks with taxpayers’ money. Controls
perpetuate a central bank’s stranglehold on power regardless of whether they are doing a
good or a bad job—and it is usually bad—in commanding the economy.

9. The command economy that central banks operate encourages the growth of debt,
rather than savings. Banks want to expand their balance sheets—i.e., to make more
loans—in order to earn greater profits, and governments want central banks to
accommodate this objective. The resulting credit expansion provides the public with
opportunities to acquire new things, which creates an illusion of prosperity that makes
people believe that their wealth is rising. The result of this debt-induced, pseudo-
prosperity is a complacent populace, the net effect of which tends to perpetuate
governmental power and politicians’ perquisites. Instead of following a sound and time-
tested, “pay as you go” policy, consumers, businesses, and governments have adopted a
new creed—“buy now and pay later.” The mountain of debt that exists in the United
States today and the excessive consumption that continues to enlarge that mountain are
the direct results of central banks’ activity and their need to grow more debt to avoid the inevitable bust that would follow if the debt growth were to stop. Newsletter writer Richard Russell explains it very simply in just three words: “Inflate or die.”xv That reality explains why Ben Bernanke (currently the chairman of the President’s Council of Economic Advisers, but also a former governor of the Federal Reserve who has been nominated to replace Alan Greenspan as Federal Reserve chairman) has said in effect that he would drop $100 bills from helicopters if necessary to inflate the economy.xvi

10. What central banks do domestically, they also do to the international monetary
system. Thus, the inherent fragility and the huge structural imbalances arising from
cross-border trading exist today because of central banks’ actions. The automaticity of
the classical gold standard ensured that imbalances such as trade deficits were relatively short-lived. In contrast, present central bank policies have perpetuated the long-running U.S. trade deficits, which are now several decades old and still growing.xvii The debt being created to finance these deficits has an impact on the monetary environment of each U.S. trading partner. Thus, central bank-engineered imbalances are not just domestic problems; they also have global implications.

If central banks are so dangerous, why do they still exist?

Having existed now for hundreds of years, central banks have survived not because they advance commerce or contribute to raising mankind’s standard of living but, rather,
solely because they are disingenuous, slavish parasites, dutifully serving the omnipotent state, no matter how mindless or harmful the state’s bidding might be. Central banks pursue reckless policies that erode—and in some cases destroy—the value of their currencies. Because of that recklessness, central banking is not only a barbarous relic, it has become dangerous as well.

Comments

Basically, the market for foreign currency translation deals with trade between different currencies. In this business, you buy a currency at a foreign currency of another type. The industry works only on speculation. The participants of currency conversion to engage in trading and buy foreign currency, expecting the currency to be worth more in the future.